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Amazon's Quarterly Report Card

Paul Larson grades Amazon's performance. Will the e-commerce giant have to stay after school?

Some weeks we really don't have much substantive news to talk about in this space. That isn't the case this week. Between Monday and Wednesday we had first quarter earnings announcements from Amgen(Nasdaq: AMGN), eBay(Nasdaq: EBAY), Celera(Nasdaq: CRA), and Amazon.com(Nasdaq: AMZN). Considering the Rule Breaker owns only seven companies, that means we've had over half of our companies report in a three day space!

Today, I'll go ahead and grade the company representing this portfolio's second-largest position -- Amazon. David touched a bit on the earnings yesterday, and I'll give my own two cents as the Fool covering the company for the Fool's Research Area. (The original Amazon research report is available for free!) On to grading some of the key metrics we're looking at closely...

1) Sales Growth: B

It should come as little surprise that Amazon reported sequentially lower sales than the seasonally juiced fourth quarter when they reported an impressive $676 million in quarterly sales. Most analysts were expecting sales between $525 and $550 million this quarter, yet I was expecting $600 million. The company split the difference and reported $574 million. Needless to say, this was significantly higher than the same quarter last year where Amazon had far fewer "stores" and only reported sales of $294 million.

Yes, I was anticipating the company to report slightly more revenue than they did, but it was by no means a large miss. After all, predicting what Amazon will do is not exactly a trivial assignment.

2) Margin Improvement: B+

The company was able to improve margins more than we thought they would be able to. Last quarter, the company reported gross margins (gross profit divided by sales) of 13%, and we were anticipating a rebound to 20%. The company reported actual gross margins of 22.3%, and the company managed to generate $128 million in gross profit versus our estimate of $120 million. Not bad, especially considering the company slightly undershot our Foolish sales estimate.

Looking further down the income statement, the company reported an adjusted net margin of negative 17.3%. This compares to our Foolish estimates of negative 20.7% and negative 27.3% in the fourth quarter. Of course, keep in mind these are all "adjusted" margins where we back out the effects of intangibles, stock-based compensation, merger, acquisition and investment-related costs. Either way, the company managed to improve both its gross and net margins more than we anticipated.

We are keeping a close eye on margins for good reason. If the company is to indeed attain profitability down the road, its sales growth must be accompanied by reduced cost per sale. The most tangible way to make sure the company is achieving efficiency is by looking at margins. It's hard to give an "A" grade when a company has negative net margins, but the direction in which Amazon's margins are headed is something we certainly approve of.

3) Outlook for the Future: A

Listening to the post-earnings conference call, Amazon's executives repeatedly talked about the "drive to profitability." At this stage in the company's life, this is the type of confident talk that we like to hear.

The skinny on what they said to expect in the near future includes:

Strong year-over-year sales growth. (Duh.)

Continued gross margin improvement throughout the year.

Fulfillment (distribution and shipping) expenses to drop into the low teens as a percentage of sales. (Last quarter they were 17.3% of sales.)

Operating losses to drop to the single digits as a percentage of sales. (Last quarter they were also 17.3% of sales.)

Increased inventory efficiency through the year.

Most importantly, Amazon expects operating cash flow to be positive for the remainder of the year. They also expect this cash flow to exceed their capital expenditures. In other words, the company's cash burn is rapidly decreasing and actually expected to turn the other way by the end of the year.

These are all incredibly positive things if achieved, and we're especially excited about the potential for cash to start flowing into instead of out of the company. Once the cash starts flowing in, a black bottom line using Generally Accepted Accounting Principles (GAAP) won't be far behind. Either way, we view the forward guidance about the company's direction to be very positive.

Needs Improvement: Partner's Health

While it wasn't really addressed in yesterday's earnings release or conference call, without a doubt the most troubling thing with Amazon today is the failing health of many of its investees in the so-called "Amazon Commerce Network." What were once profitable investments in other e-commerce companies have rapidly turned to very unprofitable ones in a short amount of time. Pull up a quote on Drugstore.com(Nasdaq: DSCM), Sotheby's (NYSE: BID), or NextCard(Nasdaq: NXCD) to get an idea what I'm talking about. (Drugstore.com made the Fool News this week.) We'll be keeping a close eye on this situation.

Overall Grade: B+

Even though many other e-tailers are starting to run into serious cash flow problems, Amazon continues to stand head-and-shoulders above its peers. The company has just over $1 billion of cash in its war chest. This should be more than enough to ward off its competitors, especially since Wall Street is extremely reticent to fund upstart online retailers these days.

The company is not profitable today, but it appears that positive earnings are something to perhaps expect in 2001. Being nowhere near mature just yet, direction is more important than location. We like the direction, and we also love Amazon's positioning against its competitors. As customers as well as investors, Amazon continues to be one of our Rule Breaker favorites.

The bottom line with this quarter's earnings is that not much has changed with the Amazon story over the first quarter. If you didn't like Amazon three months ago, nothing transpired that is likely to change your mind. Likewise, if you liked Amazon last January, there wasn't much revealed that should have you bolting for the exits. Being Fools, we're going to continue to optimistically hold our shares while watching the company grow and distance itself from its peers.

Of course, this is all just one Fool's take, and there are lots of other opinions out there, including numerous decidedly bearish ones on the Amazon discussion board. What grade would you give Amazon this quarter? Post away!